Cash investors give up more performance than they think. Holders of long-term bonds accumulate the carry and can benefit from a positive yield curve slope to generate returns via the roll-down.
Even so, investors are right to worry about what hit they may take if and when rates actually rise. While benign in the scenario that rates rise gradually, the impact can indeed be significant when rates rises rapidly. However, even then, the potential damages are often overestimated. We have looked back at US Treasury rate rise since 1977, gauging each long-term rate increase for its maximum drawdown impact and how long it took to recover from these losses. We found the duration of recovery times to be relatively self-limiting.
First, being able to reinvest coupons at higher rates contributes to the recovery. Secondly, there is an embedded pullback in any rate rise, especially for economies with high indebtedness levels. Indeed, rate rises are triggered by higher expectations of growth and inflation. But once rates have actually moved up, they impact negatively on growth and inflation prospects, driving long term rates back lower. The combined coupon and pullback effects result in portfolios recouping all of their initial drawdown in about a year at most.